In the last few days there have been scattered references in some of the research we receive about the odd situation of Japanese importers, who are natural buyers of USD/JPY, becoming net sellers of late.

The most noted of Japanese importers are the oil companies, though there are thousands of smaller companies importing everything from machine tools to agricultural products from the US. How could they they become sellers of dollars, rather than buyers?

Blame it on an invention by the banks called a “flat forward”.

Many importers buy dollars on an outright forward basis, meaning if they knew how many dollars they needed to pay for imports scheduled to arrive six months from now, they can lock them in today, with the difference between high US rates and low Japanese rates meaning they could buy dollars at a discount. They would do the same out for a year, two years…however long they felt comfortable hedging.

During the days of the JPY-based carry trade, importers made a fortune hedging their dollar needs on a forward outright basis. The banks came up with a product that made the life of the importer even easier, the flat forward, mentioned above. Instead of dealing at all different exchange rates that had different cash flows, the banks would let the importer hedge say ten years of dollar buying at one rate, with the same cash flows month after month.

Given the prevailing weak yen at the time (remember 127 in 2007, when markets were booming and the US housing crisis had yet to erupt?) and US rates in the 6% area overnight, there was good money to be made buying and sitting on dollars. Those wide interest rate differentials allowed Japanese importers to buy discounted dollars and they did so with abandon.

Years later, many of those same importers are still long dollars (and too many dollars, given slumping demand) at what are now much higher levels. That reduces what should be a source of steady demand.

But here is the kicker. Some Japanese banks are now lending their importer customers the money to let them out of these long-term commitments. That turns folks who are traditional net buyers of dollars into net sellers of dollars. Add central banks who are selling dollars to buy JPY to add to their reserves, plus the exporters who are constant dollar sellers, and it is very difficult for the greenback to sustain rallies for long.

For those unfamiliar with forwards, they are merely the difference between the prevailing interest rate for the determined time period (let’s say 1 year) of the two currencies, expressed as a discount or premium to the spot rate. To illustrate: today, USD/JPY is trading at 82.10. The 1-year forward discount is 45 pips. If you bought USD/JPY outright for delivery in one year, the rate would be 81.65…